Fitch Rates Gramercy Property Trust's Unsecured Notes 'BBB'
KEY RATING DRIVERS
The ratings are based on GPT's solid credit metrics, strong management team, granular portfolio of predominantly single-tenant, triple-net leased assets generating consistent cash flow growth, and growing unencumbered pool. Fitch expects asset quality to improve over the next several years as a result of Gramercy's capital repositioning strategy of disposing of select single - and multi-tenant assets, and reinvesting those proceeds in target industrial and, to a lesser extent, specialty assets. The primary objective of the repositioning is to reduce office exposure to less than 25% of net operating income (NOI).
These strengths are balanced by less established unsecured debt capital access and heightened exposure to office, which Fitch views less favorably. GPT continues to migrate towards a more unsecured funding model and has multiple unsecured borrowings outstanding; however, to date the company has issued only one series of unsecured notes.
As of Aug. 1, 2016, GPT owned a diversified portfolio across 29 states and the U. K. totaling 301 assets (mostly office and industrial assets), the vast majority of which were single-tenant and triple-net leased. GPT's largest market, Dallas, represents 9.1% of annual base rents, followed by Chicago (8.0%) and Los Angeles (6.5%). The portfolio is well diversified across over 200 different tenants in a variety of industry classifications. Key tenant risk is moderate with the largest tenant (Bank of America, Issuer Default Rating [IDR] of 'A') accounting for 7.5% of revenues at June 30, 2016, with the risk mitigated in part by the issuer's rating and the fact that the leases are primarily for office rather than bank branches, which have had declining utilization in recent years.
The company's portfolio generates predictable cash flows, absent tenant bankruptcies, as evidenced by annual rent bumps of 1% to 2% over a 10-20 year lease term at the onset and consistent occupancy. From 2012 to 2016, occupancy did not fall below 96% and stood at 98.5% as of June 30, 2016. GPT's weighted average remaining lease term (7.7 years) is below the net lease peer average of 10.4 years. Fitch expects this to improve as GPT completes its asset repositioning plans.
HEADLINE METRICS APPROPRIATE FOR 'BBB' RATING
Fitch projects that leverage (excluding the effects of preferred stock) will settle around 6.0x in 2018, consistent with the company's stated objective. Leverage was strong at 4.8x for the quarter ended June 30, 2016 (1Q16), compared to 5.1x for 2015. When including 50% of the company's preferred stock as debt, leverage increases by approximately 0.1x, which remains appropriate for the 'BBB' rating.
Fitch projects that GPT's fixed-charge coverage (FCC) ratio will settle in the mid-to-high 3.0x range by 2018, driven by EBITDA growth from acquisitions and developments offset in part by increased interest expense from unsecured bond issuances. GPT's FCC is solid for the 'BBB' IDR, and was 3.4x for the trailing 12 months (TTM) ended June 30, 2016, up from 3.0x in 2015 and 2.9x in 2014.
FAVORABLE DEBT MATURITY PROFILE
Debt maturities are manageable through 2018, with no year representing more than 6.2% of total debt. Beyond 2018, the maturities represent a mix of unsecured and secured debt which are larger in size but still mostly well-spaced. Fitch expects the company will be able to effectively ladder its debt maturity profile, which should reduce refinancing risk in any given year.
Fitch calculates that GPT's liquidity coverage ratio is 4.9x for the period July 1, 2016 to Dec. 31, 2017, pro forma for recent acquisitions and dispositions subsequent to June 30, 2016. Fitch defines liquidity coverage as sources of liquidity (unrestricted cash, availability under the revolving credit facility [RCF], expected retained cash flows from operating activities after dividend payments) divided by uses of liquidity (debt maturities, development expenditures and capital expenditures).
GPT maintains a conservative payout ratio, paying out 60.4% of its adjusted funds from operations (AFFO) in dividends in the second quarter of 2016 (2Q16), compared with 64.2% in the previous quarter and 50.3% in 2015. Fitch expects the company's payout ratio will sustain in the 60% range on a long-term basis, a credit positive allowing for internally generated liquidity that can be used in part to fund new investments.
EVOLUTION TOWARDS UNSECURED FUNDING PROFILE
To date, the company has only one series of unsecured notes, $150 million of 4.97% nine-year senior notes due 2024. However, other unsecured borrowings include the RCF, term loans, and convertible bonds. In December 2015, Gramercy closed on $2.075 billion of senior unsecured bank credit facilities comprising an $850 million RCF, a $300 million three-year term loan, a $750 million five-year term loan and a $175 million seven-year term loan. GPT has significantly enhanced its capital structure and is a primarily unsecured issuer and borrower, with 76% of its outstanding indebtedness unsecured. Fitch expects GPT will continue to reduce its secured debt by refinancing mortgage maturities and acquisitions with incremental unsecured debt, which should improve financial flexibility going forward.
GPT has adequate contingent liquidity from its unencumbered asset pool. Unencumbered asset coverage of net unsecured debt (UA/UD) is 2.1x when applying a stressed 9% capitalization rate to unencumbered NOI. This ratio is appropriate for a 'BBB' IDR. The company continues to pay down mortgage debt, improving the size and diversity of the unencumbered pool, while the quality remains relatively unchanged.
CAPITAL REPOSITIONING IMPROVES ASSET QUALITY
Gramercy's main asset-type focus is industrial, which Fitch views favorably due to the current supply/demand imbalance, which should result in declines in vacancy. On Dec. 17, 2015, Gramercy and Chambers Street merged, creating the largest industrial and office net-lease REIT with an enterprise value of approximately $6 billion. In conjunction with the closing of the merger, Gramercy began actively repositioning the combined portfolio through the disposition of select single - and multi-tenant assets, and reinvesting those proceeds into target industrial, and to a lesser extent, specialty assets. The primary objective of the repositioning is to reduce office exposure to less than 25% of NOI. The continued targeted reduction of office buildings will make the portfolio less capital intensive over time.
Heightened Office Exposure
Fitch views GPT's heightened exposure to office less favorably, with office comprising 32% of GPT's cash NOI for the quarter ended June 30, 2016, pro forma for the TPG transaction. Employee densification is tempering office demand at the margin, and there is higher uncertainty with suburban office, as educated millennial workers continue to seek to live primarily in urban markets, and to a less extent, transit-oriented premier suburban markets. Single-tenant suburban office can have contract rents that are difficult to replicate at lease renewal and can be difficult and costly to re-tenant and reconfigure as multi-tenant buildings. Fitch expects the company to reduce exposure of office to below 25% of portfolio NOI, and notes negative rating action may result if the company fails to do so.
Senior management has significant experience in commercial real estate, investing, and asset management. The team is led by Gordon DuGan and Benjamin Harris, who have experience working together at W. P. Carey. Together the two carry more than 40 years of direct real estate investment and management experience, while Gramercy's eight senior officers have an average of approximately 20 years of real estate experience.
PREFERRED STOCK NOTCHING
The two-notch differential between GPT's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB'. Based on Fitch research titled 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
The Stable Outlook reflects Fitch's expectation that GPT will operate within its targeted metrics through the rating horizon and the issuer will have sufficient capacity to address any potential tenant credit issues.
Fitch's key assumptions within the rating case for GPT include:
--Leverage sustaining around 6x;
--SSNOI growth of 1.5% throughout the forecast horizon;
--GPT will acquire approximately $1 billion of assets per year through 2018;
--Approximately $25 million of maintenance capital expenditures each year from 2016-2018. Capital expenditures are low due to primarily triple-net-lease structure and long-term leases.
While Fitch does not envision positive rating momentum in the near term, the following factors may have a positive impact on GPT's ratings and/or Outlook:
--Fitch's expectation of leverage sustaining below 5.0x (leverage was at 4.8x at June 30, 2016, but Fitch expects leverage to migrate to 6.0x long term);
--Fitch's expectation of FCC sustaining above 3.5x (FCC was 3.4x for the TTM ended June 30, 2016);
--Fitch's expectation of a 2.5x UA/UD ratio at a 9% stressed cap rate.
The following factors could result in negative momentum in the ratings and/or Outlook:
--Should GPT be unable or unwilling to access the unsecured debt market via public or private placement debt issuances, Fitch could downgrade the IDR to 'BBB-' as GPT would have relatively weaker access to capital and a higher-risk capitalization;
--Inability to reduce exposure to office below 25% of NOI during the two-year ratings horizon;
--Inability to execute on the monetization of Gramercy Europe during the two-year rating horizon;
--Fitch's expectation of leverage sustaining above 6.0x;
--Fitch's expectation of FCC sustaining below 2.5x.
FULL LIST OF RATING ACTIONS
Fitch currently rates GPT as follows:
Gramercy Property Trust
--Issuer Default Rating (IDR) 'BBB';
--Preferred stock 'BB+'.
GPT Operating Partnership LP
--Senior unsecured revolving credit facility 'BBB';
--Senior unsecured term loans 'BBB';
--Senior unsecured notes 'BBB';
--Senior unsecured convertible notes 'BBB'.
The Rating Outlook is Stable.